Gold Running in Short Supply

Eric Sprott founded Sprott Asset Management in 2001 and has over $5 billion in assets under management. He has been an outspoken gold bull since 2000 and warned that the bursting of the Nasdaq bubble was the start of a long-term deflationary trend that is playing out. I met him last week in Toronto.

First of two parts

EJ: You've been one of the biggest gold proponents. Where's the price per ounce of gold going?

ES: I don't have a good price target. We get involved in themes that play out for a long time. Interest rates and reported inflation started going down in the 1980s. No one dreamed of buying gold in 2000. You were an idiot talking about it. I was initially attracted to it because I thought there was a physical shortage then. There still is.

Central governments were selling gold 10 years ago. This put a burden on a very small market. Today, central governments are buying, the miners are unhedged, you have big gold ETFs, you have coin sales going crazy. Some central banks are even telling their people to buy gold.

I've got to believe that a physical shortage will manifest itself somewhere soon. There's only 162,000 tons of it out there -- and I don't know anyone selling it. Someone's going to try to buy a bar of gold sometime and it won't be there.

My partner, John Embry, went into gold many years ago because he thought it would become a substitute for fiat currencies. Governments are printing money and, sooner or later, people will realize that it's better to own gold than any bank deposits. This theme is obviously massively playing out as we speak. You look at the quantitative easing (QE) programs, budget deficits. The global fiscal irresponsibility plays into the hands of the gold owner. More people will figure it out and they'll go there.

We now have large investors -- John Paulson, to name one -- putting their money into gold. If everyone started putting 5% of their portfolios in gold, there wouldn't be enough. I'm convinced the upside for gold is still quite positive. When I see some projections for $2,000, $3,000, or $5,000 per ounce, none of them bothers me. We don't know where the price will go but it will be the inverse of QE. The more they print, the more it will go up.

The all-time high of 1980 in today's numbers is something like $2,300, but our world is different today. They didn't print money as irresponsibly then as we do now. They didn't have deficits as a percentage of GDP as large as we have today.

And there's 162,000 tons of gold in the world. That's it.

EJ: You've now come out with an NYSE-listed ETF for owning physical gold ( Sprott Physical Gold Trust ( PHYS). Can you explain why it's important to own physical gold vs. a more popular gold ETF like the SPDR Gold ( GLD)?

ES: I've always been a believer in physical gold. All the gold we own is physical gold. We're not going to buy a piece of paper or have some sort of financial counter-party between us and the gold.

Back in September 2008, the whole financial system was about to collapse. Then, five weekends ago, Europe was about to collapse. We know the vulnerability of the financial system because of its over-leveraged nature. Therefore, whenever you take on a financial counter-party, you're assuming the risk that that counter-party will be around. All these counter-parties are levered operators. That's just who they are. If suddenly everyone has to write down European bonds, they would be hit.

So, with PHYS, the key things are: It's physical gold held in Canada; the counter-party is the Royal Canadian Mint, which is a Crown Corporation of the Canadian government -- they're not going anywhere; (and) the tax rate on physical gold trust, because it's a common equity, is 18% vs. 28% capital gain on physical gold and GLD.

My feeling is it will perform totally linear with the price of gold. It will always have a little premium because it's in Canada run by trustworthy people.

EJ: If things are going to get to the point where we need to walk around with gold bars, are you planning on living in a guarded compound with months of food and fuel supplies. Will there be riots, fires, and looting? The financial system will grind to a halt?

ES: Look, I expect a crisis. We've already had two crises. They just didn't quite manifest themselves. We've been so close to the financial system breaking down -- twice. And now we've taken it to a whole new level -- to the level of sovereign risk. My goodness. If people turn their backs on sovereign bonds, where are we going? You won't be able to fund your deficits. Rates will sky-rocket.

I find the Greek example so instructive. They have massive deficits, their rates go higher, so their deficits go even higher, and their rates must go higher still. And now you're in the vicious circle. You cannot get out, unless someone from outside comes in -- or you default.

So, yeah, do I see a day when it all grinds to a halt? That's not difficult to imagine.

EJ: A financial nuclear winter.

ES: Yeah. We're already in it.

EJ: How long will it last and what's on the other side?

ES: In my view, we're going into 20 years of hard times. It should have started in 2000 but it keeps getting pushed off. The price you pay is that the inevitable reckoning just keeps getting worse. Think of the obligations of the U.S. government in 2010 vs. 2000. It's probably gone up three or four times.

I don't think the system will totally stop but I believe the underlying value of "things" and "paper" will differentiate themselves. Things will retain their value. Paper will not.

The central banks are going to have to back currencies with something more tangible than governments promising to pay. I find it really funny that we have this belief that "government equals trust." I don't get that. Why would you trust a government, of all the people? They lie.

When Osborne became the new chancellor of the UK, he said "all the data we were given was wrong." Would we find that out with other governments of the world? If you're a politician, you twist the data because politics is more important than democracy or the financial system.

EJ: You've made a point that the Canadian government sold all its physical gold a few years ago at market lows. Which countries are best positioned in terms of owning gold?

ES: I would guess Switzerland, Germany, France, and possibly Italy are good, in terms of having gold. I haven't checked the data. Russia's coming on. China's trying to accumulate gold, but per capita, they don't have much.

We all debate whether the U.S. has their gold. That's the real debate. Was the physical gold supplied by the central bank surreptitiously? That's the question that nobody has the answer to. But, when you realize that all this new demand should not have been easy to supply, I wonder who is selling the gold.

EJ: Does it make you nervous when you see people hawking gold on late-night TV infomercials? Is it a crowded trade?

ES: Some of these guys on late at night are buying gold and some selling it. The ones buying it make sense. It's a statement of demand for gold. And they're ripping people off. They turn right around and sell it and there's a huge market for it. I think a lot of desperate people in the U.S. have now sold their gold trinkets because they needed the money last year. It's stunning to think a little gold ring someone's got stashed away could be worth $1,000.

What I keep wondering -- when you think of all these new buyers of gold today vs. 10 years ago -- is where's the gold coming from? I can't think of anyone who would be selling gold now. You think the guys in the Middle East are selling gold now? No way. Not is this environment.

Part II of this interview will be printed tomorrow in TheStreet. Jackson held no position in the stocks mentioned at time of publication.

At the time of publication, Jackson did not hold positons in any equities mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson